Social Security in the Cross Hairs

January 21, 2016

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Social Security may be at risk after the November elections.
Critics are writing op-eds saying that benefits – relative to previous earnings
– are very high, and the Congressional Budget Office (CBO) has come out
with an astounding estimate of the 75-year deficit. The stage is being set
for benefit reductions. Cutting benefits would be a huge mistake, given that
half the private sector workforce does not participate in an employer-sponsored
retirement plan and that those lucky enough to participate in a 401(k) have
combined 401(k)/IRA balances of $111,000 as they approach retirement.
Therefore, it is very important to take a hard look at the emerging
characterization of the Social Security program. This blog focuses on the
75-year deficit.

The 75-year deficit is the difference between the income
rate and the cost rate. The income rate is calculated by adding the current
trust fund balance to the present discounted value of scheduled taxes and then
dividing by the present discounted value of taxable payroll over the 75-year
period. The cost rate is the present discounted value of scheduled benefits
divided by the same payroll number. In 2015, the Social Security Trustees
Report had an estimated deficit equal to 2.68 percent of taxable payroll.
That figure means that if payroll taxes were raised immediately by 2.68
percentage points – 1.34 percentage points each for the employee and the
employer – the government would be able to pay the current package of benefits
for everyone who reaches retirement age at least through 2089.

Is 2.68 a reasonable number? Every four years, Social
Security establishes a Technical Panel to evaluate the Trustees’ projections. I
chaired the Technical Panel in 2015, and we concluded that the Trustees’
assumptions unequivocally were reasonable.

That said, we offered our preferred alternative for
a number of assumptions. Specifically, the Technical Panel suggested: 1) more
rapid mortality improvement, which means that people will live longer and
receive more total Social Security benefits; lower fertility, which reduces the
population at working ages relatively to the elderly population; and lower
interest rates, which mean that revenues and benefits are discounted by a lower
number. These cost-increasing changes raised the 2.68 percent deficit in the
2015 Trustees Report to 3.42 percent. (The net increase would have been lower
if the Panel had quantified the impact of assumed greater labor force
participation.)

I think my liberal friends are disappointed that the Panel
adopted assumptions that increased the 75-year deficit by such a large amount.
But I look at it this way. The Panel pulled no punches, ignored the cost
implications when making its recommendations, and the worst that it could do is
to increase the long-run deficit by 0.7 percentage point.

My experience with the Technical Panel makes it very
difficult to understand the new CBO deficit estimate of 4.37 percent. The CBO
report cites three main reasons for the difference between the Trustees’ and
CBO’s estimates (2.68 percent versus 4.37 percent): mortality improvement,
disability incidence, and interest rates. But the Technical Panel increased
mortality improvement significantly and reduced the interest rate, as well as
reducing the fertility rate and did not come close to the CBO number (see
Table).

Policymakers should view the reasonable range as between the
Trustees and the 2015 Technical Panel (2.68 percent and 3.42 percent). In other
words, the Trustees’ assumptions are reasonable, and the Technical Panel’s
recommendations are reasonable. Only time will tell which of us comes closer.